FX Costs Are Slashed As Tech Brings Transparency &amp; Efficiency

Tom Groenfeldt
, ContributorI write about finance and technology.Opinions expressed by Forbes Contributors are their own.

Foreign exchange is changing, and it is changing because of lawsuits against the Bank of New York Mellon and State Street, accusing them of giving investment management and pension fund clients prices that are much better for the custodian than for the investment managers.

(State Street released a statement on the topic: “State Street continues to cooperate with inquiries regarding our indirect FX services and vigorously defend the litigation that has been commenced against us. We offer clients and their investment managers a range of FX execution options and we believe that our clients and their advisers choose indirect FX as an execution option when it represents the best mix of service and price to address their needs.”)

And the FX market is changing because of technology platforms like Integral, which describes its business as: “Integral provides an on-demand, multi-sided trading network for foreign exchange which firms can private-label to operate their own automated private FX business. Its private trading solutions are managed and operated over Integral’s FX Grid, a global inter-institutional connectivity and trading network, linking market making banks to FX market participants.”

By using Integral’s technology, said Harpal Sandhu, Integral’s CEO, market participants can offer FX without building any infrastructure.

I caught up with him at the Futures Industry Association conference in Boca Raton, and he was eager to talk.

“We believe our technology is one of the catalysts that is democratizing the OTC side of FX markets because it allows everything to be electronically connected,” Sandhu explained. “If we look at the history of OTC markets, they tend to be opaque. If you are participating in the market as a market maker, opaqueness is your friend but electronification has led to greater transparency.”

For years, he said, big banks have operated the FX transactions for investment managers with no accountability, and with an impenetrable marketplace where fund managers don’t know how the price they pay for a currency compares to the market price.

Integral has offered foreign exchange trading for years in the unregulated part of the markets, he added. Now regulators are forcing that same transparency and electronification into the derivatives portion of FX, such as non-deliverable forwards (NDFs). The regulated part of the market drives about 45 percent of the volume he added. And if a transaction touches the U.S., it is apt to come under U.S. regulation.

“Regulation is driven out of the U.S. The Japanese and Europeans are following suit with 80-90 percent overlap with U.S. regulations, after a 6-24 month delay. This will affect the whole world.”

Integral has been promoting transparency in FX markets for seven years, Sandhu said. Now the customers are beginning to understand that this is to their benefit. Exactly why did it take them so long?

In late November Tim McLaughlin at Reuters reported that Fidelity was pushing BNY Mellon for more details on its FX pricing.

“The Boston-based firm is now requiring more data from BNY and others about the specific timing and pricing of any foreign-exchange trades that aren't directly negotiated, Fidelity spokesman Steve Austin said. And Fidelity has enhanced its forex cost analysis as it works to lower expenses for its mutual fund investors, Austin added.”

Investment managers just thought FX charges were a cost of doing business, said Sandhu.

“It wasn’t their primary business.”

The high prices of FX transaction came to light when employees of the banks left and filed whistle-blower complaints, which entitle them to a share of money recovered from government entities, such as government pension funds.

“Now the customers [i.e. pension funds and investment managers like Fidelity] who are fiduciaries to their investors are embarrassed,” added Sandhu. “They want to fix it.”

Enter Integral whose technology platform provides transparent pricing and best execution at low costs, charging around $8 to $10 per million dollar traded.

Sandhu said that the custodian banks who are now facing challenges in court conducted their FX transactions throughout the day, executing and off-setting their risk. At the day’s end, they typically charged clients the highest intraday price for the buys and the lowest for the sells, and tacked on transaction fees that could range up to $5,000 for a million dollar transaction.

With Integral, firms can pick the best price in the marketplace from offers posted by multiple banks. They can also net out their FX exposure and transact for just the remainder they need.

“After all,” said Sandhu, “the cheapest way to execute is never to execute at all. The banks were forcing their customers to execute everything and not at the spread at the time but at the day high and low.”